Why Think Luxembourg for a Multinational Headquarters?

Download the paper in PDF

Luxembourg offers an attractive regime to locate the headquarters of multinational enterprise (“MNE”). In addition to flexible legal framework and corporate governance rules, a range of tax advantages are available for such headquarters. This allow for efficient tax planning using not only the possibilities offered by domestic tax law, but also the opportunity to locate specific activities in branches established in a more friendly jurisdiction depending on the type of activity envisaged.

 In addition, tax efficient profit repatriation schemes may be easily structured.

What type of company should be used for Luxembourg based MNE headquarters?

·        No specific corporate form is required. As for financial participation companies, those companies are ordinary Luxembourg companies subject to common tax and company legislation.

·        The activities must be limited to intra-group transactions, otherwise the headquarters will be considered as a financial institution requiring an authorization from the financial services regulator.

What are the basic tax advantages offered by Luxembourg tax law for MNEs?

·        The participation exemption regime on dividends received from and capital gain made on the sale of qualifying participation is quite attractive (see FPC brochure)

·        The withholding tax on dividends paid out may be avoided by using proper planning.

·        There is no withholding tax on liquidation proceeds, royalties and interest payments (save for certain profit participating schemes).

·        The approach of the tax administration regarding thin capitalization (in absence of legal rules) is relatively flexible.

·        Tax losses may be carried forward indefinitely.

·        Through the application of the “arm’s length principle”, the 30.38% corporate income tax rate only applies to:

o       The remuneration of the activities effectively carried out by the headquarters and of the risks incurred. In the case of a intra-group back-to-back financing, the tax base only consists in a small interest spread (from 1/4 to 1/32%, depending on the amount involved);

o       The profit share generated by the Luxembourg head office (up to 5%) on activities carried out by a foreign branch.

·        The application of the arm’s length principle by the tax authorities, as well as the tax deductibility of specific expenses, may, in certain circumstances, be secured in advance by an informal tax ruling, thereby providing more certainty and reliability to the structure.

What is the “branch arrangement” and how does it work?

·        Although Luxembourg companies are taxable on a worldwide income basis, profits made by foreign permanent establishments are excluded from their tax base. Nevertheless, a certain profit share may be allocated to the head office, depending on the activity effectively carried out therein and on the provisions of the tax treaty with the country of location of the branch.

·        Some countries, having entered into a tax treaty with Luxembourg, offer an efficient tax regime for specific activities (ex: Switzerland for certain intellectual property arrangements, US for certain financial transactions, etc…). Group activities, regarding those activities, are made by the Luxembourg headquarter through the local branch.

·        The overall tax burden on the activity is significantly reduced as the taxation at branch level is relatively low and the Luxembourg 30.38% tax only applies to 5% of the overall profits.

·        Care must be taken, in the case of a US based MNE, to ensure that the Luxembourg headquarter may benefit from the US tax treaty by meeting relevant conditions laid down in the “limitation on benefit article” (including the “base erosion test” as the case may be).

What about repatriation schemes optimization?

·        The Luxembourg-US tax treaty provides for 5% withholding tax on dividends.

·        Luxembourg does not apply withholding tax on (full or partial) liquidation proceeds. For a MNE investing purely in the capital of the Luxembourg headquarter, it is possible, for instance, to create various classes of shares and to liquidate / redeem one or more of them to repatriate profits (withholding tax free) as partial liquidation.

·        As Luxembourg generally does not apply withholding tax on interests, a privileged manner to invest in the headquarters, allowing withholding tax free repatriation, is via debt instruments.

·        The tax administration’s thin capitalization practice consists in considering a 85% (in some cases 99%) indebtedness as a safe heaven, debts contracted for the purpose of back-to-back financing (i.e. to finance another group entity) being excluded in the computation of that percentage.

·        Moreover, some investment instruments “hybrid instruments” are qualified as debts instruments in Luxembourg, but may have another qualification or a favorable treatment in the MNE’s home country, as, for instance, convertible preferred equity certificates (“CPECs”) in the US. In Luxembourg, CPECs are considered as debt instruments, the remuneration thereon (paid or accrued) is tax deductible, withholding tax free when paid, and the reimbursement or redemption of which does not attract any Luxembourg tax liability.

·        Thus, the use of relevant hybrid finance instruments allows the creation of efficient tax repatriation schemes, which may be secured by requesting a tax ruling from the tax authorities to ensure the tax treatment and any potential thin capitalization issue.

The above constitutes a commonly used scheme for US MNEs, but other efficient schemes may be used depending on the tax and legal regime in force in the country of residence of the mother company (that may not necessarily be the group’s leading company) of the Luxembourg headquarters.